To what extent has liquidity levels recently impacted financial assets?

Over the last six months, financial market liquidity has played a major role in supporting credit and equities prices in spite of large fluctuations in Fed forecasts. But with April’s tax deadline drawing near, the liquidity situation is becoming less clear, which might cause uncertainty and increased volatility in the financial markets.

The amount of money that market participants have at their disposal and their capacity to interact without having a significant impact on prices are two definitions of liquidity. The quantity of monetary liquidity that is accessible to markets is mostly determined by the actions of the Fed and Treasury. The Fed can infuse or drain monetary liquidity through its balance sheet and interest rate policies, while the Treasury can influence liquidity by changing the profile of government debt issuance.

Total US liquidity has been increasing since October 2023, especially due to a smaller Treasury bill issuance profile and a decrease in the Treasury General Account. This decrease in spending keeps more funds in the private sector, driving spreads close to cycle lows, which have not seen since 2021.

Tax receipts will boost the Treasury’s coffers, which is a net drain from the private sector to the Treasury. It will be instructive to see the level of tax receipts around the April 15th deadline, estimated to be around $500 billion, most of which will be coming from bank reserves.

While disruption to interbank funding markets should be minimal in the near-term, the focus will be on the Treasury’s refunding announcement on May 1st, when the issuance calendar for both T-bills and coupon bonds is released. A higher level of T-bill issuance than expected would result in a bigger drain on the Fed’s reverse repo facility/private sector bank reserves. If the Treasury elects to issue more coupon bonds, markets must contend with a higher level of duration risk, which could have ripple effects for financial assets across the risk spectrum.